Tighter Monetary Environment And Regulations To Weigh On Credit Creation

We expect China's overall credit creation to moderate over the coming months due to a tighter monetary policy environment and increasing oversight of the opaque shadow banking sector amid efforts by policymakers to reduce overall financial risks that have built up over the past few years.

We believe that Chinese policymakers will continue to curb financial risks as well as reduce the economy's reliance on easy credit, which suggests that monetary policy will become tighter over the coming quarters. Indeed, the theme of risk prevention was highlighted during the five-yearly National Financial Work Conference (NFWC) held on July 14 to 15, and containing risks has also been a recurring discussion topic during the Politburo meetings chaired by President Xi Jinping since December 2016. In the latest Q2 Monetary Policy Report released by the People's Bank of China (PBoC) on August 11, the central bank also stated that it seeks to deepen financial regulation through strengthening co-ordination in financial oversight. We are therefore maintaining our expectations for overall credit creation in the mainland economy to moderate due to the tighter monetary environment and increasing oversight on opaque shadow lending. According to the People's Bank of China (PBoC), China's total social financing (TSF) stock expanded by 12.8% y-o-y in June (slightly slower than 12.9% y-o-y in May), and we expect that it will likely head lower over the coming months.

Market-Based Interest Rates Likely To Head Higher

China - 1-Year SHIBOR And Benchmark Lending Rate, %

Source: BMI, Bloomberg

Draining Liquidity From OMO

The tighter monetary policy environment can be seen from the significant rise in interest rates in the interbank and bond markets since the start of 2017, and we believe that this trend will likely continue. Indeed, the PBoC has hiked various short-term interest rates used in its open market operations (OMO) such as reverse repurchase agreements and the medium-term lending facility since the start of 2017, despite keeping its 1-year benchmark lending rate unchanged at 4.35% since its last reduction by 25bps in October 2015. According to data from Wind, the central bank withdrew CNY1.3trn worth of liquidity through its OMO in the first seven months of 2017, which was in contrast to the net injection of CNY197.3bn and CNY3.2trn worth of liquidity for the same period last year and for the whole of 2016, respectively.

Withdrawing Liquidity

China – PBoC Open Market Operations, CNYbn

Source: BMI, Wind

Seeking To Curb Shadow Banking Sector

We believe that the PBoC will continue to work with other regulators such as the China Banking Regulatory Commission (CBRC) to fine-tune their oversight on the shadow banking sector over the coming quarters through macro-prudential policies. For example, the inclusion of wealth management products (WMPs) into the central bank's macro-prudential assessment (MPA) and increased scrutiny by the CBRC have resulted in a slowdown in the balance of outstanding WMPs. Indeed, the growth of WMPs balance decreased significantly to 8.9% y-o-y in May, from 18.6% y-o-y in Q117.

WMPs Likely To Trend Lower

China - Outstanding Balance Of WMPs, CNYtrn And % chg y-o-y

Source: BMI, ChinaWealth.com, CBRC, Various news sources

In addition, as reported by Xinhua News on August 5, the PBoC stated that it plans to include large systemically important internet finance firms in its MPA as it aims to improve its regulation over this category of shadow financing. While data from Wind showed that the expansion in the amount of peer-to-peer (P2P) lending (a part of internet financing, which accounts for only 1.4% of GDP) has slowed significantly from more than 350% y-o-y in September 2015, it was still growing rapidly at 68.6% y-o-y in July.

Furthermore, despite some success in curbing the growth of WMPs, we note that the disbursement of other shadow loans (such as entrusted loans and trust loans, which in total account for 27.3% of GDP) that are accounted in the total social financing (TSF) are showing signs of acceleration. It is therefore highly likely that the crackdown on the shadow banking sector will be increasingly broadened towards these categories over the coming quarters. Indeed, the PBoC highlighted the need to strengthen prudential oversight in the asset management industry, which was estimated at over CNY60trn at the end of 2016, in its Q2 Monetary Policy Report.